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Economic Signals To Watch

The latest economic news this week was good again but the risk of a stock market reversal rose and inflation suddenly appears directly ahead.

The Non-Manufacturing Purchasing Managers Index for February was released on Friday and it came in at a strong 57.6%. With this index, a persistent reading of less than 50% presages a recession. So the February number and upward move is a positive sign. Non-manufacturing accounts for 90% of U.S. jobs and 86% of the economic activity in the U.S., according to federal government data.

With the manufacturing sector of the economy accounting for 10% of American jobs and 14% of economic activity, February's 57.7% reading of this index of purchasing managers in manufacturing businesses was extremely strong and continued a surge that began in September. Since 1989, the index rarely has been so high.

New orders is a key component of both the manufacturing and non-manufacturing indexes. The new orders number is a forward looking figure and shows new business coming into the pipeline of businesses. At 65.1%, new orders in February are about as strong as they have been in years. Meanwhile, the sub-index measuring new orders in the non-manufacturing segment of the economy, also remained strong, at 61.2%. The pipeline of new business making its way into the economy in February was strong, which bodes well for the economy in the weeks ahead.

Consumer income drives spending by consumers and represents 70% of U.S. economic activity. It's shown here in its component parts. Of the five components comprising consumer income, employee compensation is by far the most influential. The 4.4% rise in employee compensation for the 12 months through the end January 2017 is a booming increase. In the last economic expansion, the peak rate of growth in employee compensation was 3%. Employee compensation, which is made up of wages, salaries, benefits and employer contributions for Social Security and Medicare, is growing at a rate nearly 50% higher than in its peak rate in the last economic expansion.

Disposable personal income - what's left of consumer income after taxes - is accelerating.

Disposable personal income and spending have been in recovery for seven years following The Great Recession of 2008. Because personal spending accounts for 69% of U.S economic growth, the rate of change in personal spending is key to the rate of change in U.S. growth.

The other number on this chart is personal saving rates. At 5.5%, Americans are saving at a much higher rate than in the decades before The Great Recession. U.S. household balance sheets are in much better shape.

While all of the data show the economy is on a strong footing, a couple of signals are changing. One of them is inflation.

The Personal Consumption Expense Deflator (PCED) is the barometer of inflation used by the Federal Reserve to set economic policy. The Fed has long had a target of 2% inflation but the slow growth economic recovery since The Great Recession has occurred with almost no inflation. The latest PCED data through the end of January spiked up from 1.6% to 1.9%.

On Friday afternoon, Janet Yellen, Federal Reserve chair, in a speech before The Executives' Club of Chicago, said the nation's central bank would raise rates in March barring any unexpected events in the economy. "We realize that waiting too long to scale back some of our support could potentially require us to raise rates rapidly sometime down the road, which in turn could risk disrupting financial markets and pushing the economy into recession," said Yellen. "Having said that, I currently see no evidence that the Federal Reserve has fallen behind the curve, and I therefore continue to have confidence in our judgment that a gradual removal of accommodation is likely to be appropriate."

Inflation has been expected to come back but this marks a new phase in the expansion, as the PCED finally is approaching the Federal Reserve's target rate of 2%.

The other signal changing is the stock market, which since the election on November 8, the Standard & Poor's 500 stock index soared by 12%. While stocks averaged about a 10% annual return since the modern Wall Street era began about 80 years ago, the price of the average company in the S&P 500 gained more than that in just the past 11 weeks. Stock prices have soared because economic data are strong but also because investors have begun to expect a tax break to be enacted. Last week, with political intrigue dominating headlines, little progress was made toward enacting health care legislation or cutting corporate and personal taxes. If politics gets in the way of cutting taxes and writing a new health care law, the stock market could be vulnerable.

Major U.S. stock indexes eked out fractional gain on Friday and the S&P 500 closed at 2,383, slightly lower than the all-time high reached on Wednesday.

With fake news and alternative facts flourishing, our weekly reports are not intended as advice but as a source of prudent analysis about news affecting your wealth over the long run. Please feel free to share them with your family and friends.

This article was written by a veteran financial journalist based on data compiled and analyzed by independent economist, Fritz Meyer. While these are sources we believe to be reliable, the information is not intended to be used by as financial advice without consulting a professional about your personal situation.

Indices are unmanaged and not available for direct investment. Investments with higher return potential carry greater risk for loss. Past performance is not an indicator of your future results. Investing in foreign securities carries political and currency risks.

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This article was written by a professional financial journalist for McCarthy Asset Management, Inc. and is not intended as legal or investment advice.

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